The Outlook for the Rest of 2017Submitted by CHARLES CARROLL FINANCIAL PARTNERS on August 8th, 2017
Where will the market be heading the rest of 2017?
While it is nice to feel that the market is providing great returns this year, it is important to understand what has occurred.
While the return of the markets in general is greater than what it has been in the past few years, since the end of March the S & P 500 is only up 4.5%. This means that much of return for most portfolios occurred in the first 90 days of the year. Since the end of March, the market has been active, but is lazily moving forward.
Please remember that in an earlier quarterly report we suggested that “index” investing was pushing the market forward. The largest of the large capitalized firms have been receiving the majority of “new” money going into the market. However, even that tidal wave of cash is starting to recede (see below), and we believe this is influencing the valuation of the largest companies.
Since mid-July, the likes of Google, Amazon, Facebook, and Microsoft have seen their market price per share pull back or remain stuck in a trading range. Even the positive earnings that have been reported in the past few weeks could not propel these large names to higher levels. This is a sure sign that equity valuation is ahead of earnings and makes us cautious of future moves up in the short term.
Hold on to your hats as we go into late August and September. The overall market is directionless and looking to move where value is most evident. The Federal Reserve has been helpful to financial stocks and as the likelihood of higher interest rates seems plausible. The larger "national" banks, as well as broker/dealers, should have upside opportunities. Look for BAC, GS, and C to do well.
An Evidential Source of Market Direction?
The Investment Company Institute (ICI) reflects NEGATIVE equity mutual fund purchases for the month of July 2017. This is a significant change from the $159 Billion in new equity ETF funds and $61 Billion in new equity mutual fund purchases in June 2017.
NEGATIVE July 2017 mutual fund flows may be indicative of investors not willing to place their hard-earned cash into an overheated market.
It is important to point out that FLAT equity mutual fund investing changes the way that a manager of an equity mutual fund must manage his/her fund. A lack of new cash may require the manager to sell shares due to redemptions. In addition, opportunities in the market may not be fully pursued due to a lack in liquidity.
Over the course of the past 12 months, equity ETF assets have increased $714 Billion, or 32%. Total dollars in mutual funds, on the other hand, have increased 0.4% since 2016 for the same period. This points out the trend in the industry to reduce the cost of investing by moving away from mutual funds to ETFs, as well as the enormous and troubling move by investors toward index funds.
A great article by Jeffrey Kleintop at Charles Schwab entitled, "What are fund flows telling us about trends and risks in the global stock market?" points out the enormous discrepancy in ETF and Mutual Fund equity net flows since 2014. One of the reasons for this increasing preference discrepancy between ETFs and Mutual Funds is the use of Synthetic ETFs and Creation Units. Synthetic ETFs fuel this discrepancy as they use derivatives and swaps to leverage exposure or mitigate risk quickly and indiscriminately. It is not uncommon for firms to "create" their own creation units of share in order to trade ETFs intraday. The ability to trade securities "intraday" creates another distinct advantage of ETFs over comparable mutual funds.
Getting back to Mr. Kleintop's article, goes on to state that in the first 6 months of 2017, the propensity of investors has been to look for opportunities overseas rather than in the U.S. It is apparent that investors believe that the U.S. equity market looks fully valued, while opportunities outside of the U.S. equity market are being pursued by ETF investors.